Slowing consumer expenditure has attracted policy attention this year. After raising the personal income tax threshold in February’s budget, fiscal focus turned towards indirect taxes, or the goods and services tax, in this quarter. Fundamental changes in its rates are expected to lower the consumption tax burden, boosting disposable incomes of households amongst the other effects of the overhaul. The reformation is significant, and the government anticipates a substantial uplift in consumer demand in response. The stakes are high. Will the gamble work?
The GST’s broader reform was on the policy agenda for some time. The underlying principles of its makeover are replacing the four GST rates with a dual-rate structure with wide simplification of processes and procedures for easier conduct of business. The reworking shifts more than 300 items from the 12%, 18%, and 28% GST groups to the 5% category, another 30 items from the 28% to the 18% group, while ‘sin’ or luxury goods will now be taxed higher at 40%. Services like civil public works, motor vehicle rentals, premium air travel, sporting event tickets, and gambling activities will also be taxed at 18% instead of 12% before. These are only illustrations and not the entire range. Directionally correct, the changes should be of general benefit to the economy.
The main alleviation of living costs for low-income households, the largest population segment, comes from GST reductions in bulk of the items of daily consumption — inter alia, basic household and food products, medicines, consumer appliances, small motor vehicles, common personal care services and so on; health and life insurance policies have altogether been freed along with specific drugs and medicines. Based upon the monthly consumption expenditure basket, one estimate shows
the reductions cover about one-third of this; 47% is now GST-free compared to 35% before.
The prominence to consumption occurs in a backdrop of growing pressures upon household budgets. Since the GST’s institution in 2017, aggregate indirect taxes have grown faster than personal income in five of its eight years of existence till 2024-25. In the last four years — without doubt the hardest of times because of the pandemic, high inflation, including food prices, increased unemployment and number of workers slipping back to agricultural dependency — net product taxes like GST, fuel duties and so on grew faster than national output and per capita incomes did.
This buoyancy fetched the government more revenues, enabling higher spending in turn. But it also dampened household disposable incomes and welfare. Add to this the squeeze from higher inflation in these years, especially foods where the price rise has been no less than an average 7% in the last three years. The erosion in buying capacity of households has not been inconsiderable as a result.
The evolving composition of the GDP, approximately 60% of which is consumption, reflects these strains. In the last two years, private consumer expenditure shares in GDP (accounting for inflation) slipped after the temporary rebound upon reopening in 2021-23. It is no better than what it was before the pandemic. The latest national accounts data show real spending by households has steadily weakened quarter upon quarter from January.
The portrait would be incomplete without acknowledging the importance of debt or borrowings in upholding consumption in this period. Total household borrowings increased steeply in 2022-24, approximately twice of that in 2021-22. Thereafter, defaults on consumer loans, especially unsecured and small personal ones, have been rising as growth slowed and interest rates remained high. The central bank thus tightened regulations to check unbridled credit growth and banks raised lending standards in response. The total financial liabilities of households climbed down as a result last year, indicating cutbacks and weakened financial strength. Household debt is still historically high, and balance sheet repair may take time.
These developments are unquestionably concerning for policymakers, especially with economic growth slowing down sharply as it did last year and business spending failing to respond despite continuous public capex stimulation. Consumption assumes policy importance in this light.
Effective September 22, the ‘Diwali gift’ is expected to light the spark in consumption by bolstering disposable incomes and spending power through lower prices. What can be expected?
Although lower prices should increase consumption in response, the actual price decline matters. This is presently unclear. The complete overhaul in the GST rate structure complicates precise estimation. The price fall will also depend upon the extent to which firms pass the tax cuts on to consumers; this is often a smaller share as some part is retained to increase profit margins. However, with the government keeping a keen watch, wide advertisement, and sufficient clarity on vehicles — small cars and two-wheelers are likely to be cheaper by 8%-9% — we can expect moderation in some but not all prices.
The immediate response will be mixed with the festival-season spurge. This typically sees a rise in all kinds of expenditure, essential as well as discretionary purchases like vehicles, air-conditioners, other consumer durables, and so on. Any permanent increase in final consumption expenditures and the levels thereof will be known only after seeing through this temporary spurt.
The final but the most important factor is that fundamentally consumption is driven by income and employment growth. The jobs’ situation is well known to be weak. Economic growth, too, is on a downswing, notwithstanding the brisk acceleration in real GDP in the June quarter — no less than 7.8% upon that of last year. However, growth slowed down in sequence over March and was flat on a four-quarterly average basis.
Macroeconomic policy stimulation can help navigate a temporary downturn but if the economic weakness is more fundamental, the returns on this reformation will take time to show. A similar fiscal stimulus, but with deeper and across-the-board cuts in excise duties and Central value added tax in 2008 to offset the global financial shock, did uplift aggregate consumer spending that eventually tapered off in the next two years.
Renu Kohli is Senior Fellow, Centre for Social and Economic Progress. Views are personal
